Group Chief Financial Officer's review

A resilient FY'21 performance returning to top line growth in 2H'21, an increased dividend and a buy-back

The Group delivered a resilient performance in 2021, returning to top-line growth in the second half of the year. In conditions that remained challenging the Group delivered strong underlying profit growth of 61 per cent on a constant currency basis, and 300 basis points increase to return on tangible equity (RoTE) to 6 per cent, benefiting from significantly lower credit impairment. Income was broadly flat to 2020 and was down 1 per cent on a constant currency basis, reflecting the $0.7 billion income lost in 2021 due to the low interest rate environment. After declining 6 per cent in the first half of the year on a constant currency basis excluding the impact of the debit valuation adjustment (DVA), the Group delivered 4 per cent income growth in the second half. The Group grew loans and advances to customers by 6 per cent and delivered a record level of assets under management within Wealth Management. Expenses were up 3 per cent on a constant currency basis as performance-related pay normalised after an abnormally low 2020 and as the Group continues to increase investment in strategic initiatives. Credit impairments reduced by $2 billion reflecting the non-repeat of prior year stage 3 charges and an improving economic backdrop as markets began an uneven recovery from the effects of COVID-19. The Group remains well capitalised and highly liquid with a Common Equity Tier 1 (CET1) ratio of 14.1 per cent, which translates to a pro forma 13.5% as at 1 January 2022 incorporating upcoming regulatory changes, enabling the Board to announce a further $750 million share buy-back programme to start imminently.

All commentary that follows is on an underlying basis and comparisons are made to the equivalent period in 2020 on a reported currency basis, unless otherwise stated.

•     Operating income was broadly flat and was down 1 per cent on a constant currency basis

•     Net interest income decreased 1 per cent with increased volumes more than offset by an 8 per cent or 10 basis point reduction in net interest margin. The decline in the net interest margin was as a result of the low interest rate environment and is equivalent to $0.7 billion of lost income. Net interest income included a positive $171 million IFRS9 interest income catch-up adjustment in respect of interest earned on historically impaired assets, increasing the net interest margin by 3 basis points

•     Other income was flat, with a record performance in Wealth Management and strong fee growth in Transaction Banking offset by lower trading income in Financial Markets and lower realisation gains in Treasury

•     Operating expenses excluding the UK bank levy increased 5 per cent but were flat on a constant currency basis after adjusting for the normalisation of performance-related pay in spite of a higher inflation environment. Expenses were held flat as the Group funded continued investment in transformational digital capabilities through cost efficiency actions. The cost-to-income ratio on a constant currency basis (excluding the UK bank levy and DVA) increased 272 basis points to 70 per cent, however in the second half of the year the Group delivered 260 basis points of positive operating leverage. The UK bank levy decreased by $231 million to $100 million reflecting a change in the basis of calculation as it is now only chargeable on the Group's UK balance sheet

•     Credit impairment was $263 million, a reduction of $2 billion. Corporate, Commercial & Institutional Banking impairments declined by $1.6 billion as it recorded a net release of $44 million. Consumer, Private & Business Banking impairments were $285 million, primarily stage 3 impairments, down $456 million. Central & other impairments totalled $22 million, broadly flat in the year. Total credit impairment of $263 million represents a loan-loss rate of 7 basis points, a year-on-year reduction of 59 basis points in our cost of risk

•     Other impairment was $355 million, an increase of $370 million. This includes a $300 million impairment charge relating to the Group's investment in its associate China Bohai Bank (Bohai) following the announcement of its most recent results. The remaining other impairment primarily relates to aircraft

•     Profit from associates and joint ventures increased 7 per cent to $176 million. In 2020, the Group could only recognise its share of the profits of Bohai for ten months due to the timing of its initial public offering in July 2020, after which the Group's share of Bohai reduced to 16.26 per cent from 19.99 per cent

•     Charges relating to restructuring, goodwill impairment and other items reduced by $346 million to $549 million, with $125 million higher restructuring costs more than offset by a non-repeat of $489 million goodwill impairment primarily relating to India and UAE booked in 2020

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•     Taxation was $1,034 million on a statutory basis. Taxation on underlying profits was at an effective rate of 28.8 per cent, a decrease of 8.9 per cent compared to 2020. This reflects a favourable change in the geographic mix of profits, the impact of a lower UK bank levy which is non-deductible and higher profits diluting the impact of non-deductible costs. Taxation on statutory profits was at an effective rate of 30.9 per cent, an increase of 1.9 per cent on the underlying rate due to restructuring costs incurred in low tax jurisdictions

•     Return on tangible equity increased 300 basis points to 6.0 per cent due to the increase in profits

•     Underlying basic earnings per share (EPS) more than doubled to 76.2 cents and statutory EPS of 61.3 cents increased by 50.9 cents

•     A final ordinary dividend per share of 9 cents has been proposed along with a share buy-back programme of $750 million which will start imminently

Summary of financial performance

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Change is the basis points (bps) difference between the two periods rather than the percentage change

3 Not meaningful

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Statutory financial performance summary

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Change is the basis points (bps) difference between the two periods rather than the percentage change

3 Not meaningful

Operating income by product

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Not meaningful

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Following an organisational restructure that came into effect on 1 January 2021, the Group's Financial Markets business has been expanded and reorganised, with the Group integrating the majority of its Corporate Finance

Group Chief Financial Officer's review continued

business within Financial Markets. The remaining elements of the Group's Corporate Finance business - primarily M&A Advisory - have been transferred into Lending & Portfolio Management.

Transaction Banking income was down 9 per cent. Trade increased 16 per cent reflecting high single-digit growth in trade volumes from a significant rebound in global trade as economies recover from COVID-19. Cash Management declined 22 per cent with the low interest rate environment leading to margin compression despite repricing initiatives. This was partly offset by double-digit growth in volumes and fees.

Financial Markets income was flat, or down 2 per cent excluding the impact of a IFRS9 income adjustment, with strong performances in Credit Markets and Structured Finance offsetting a double-digit decline in Macro Trading income which was impacted by a non-repeat of 2020's exceptional market volatility. Credit Markets income grew 12 per cent, or 7 per cent excluding the impact of a $94 million IFRS9 income adjustment, with increased client demand growing both origination and distribution volumes. Structured Finance was up 25 per cent benefiting from increased leasing income due to new deals and profits from the sale of aircraft. Financing & Securities Services income was up 6 per cent with increased Security Services income partly offset by margin compression and lower demand for corporate term deposits.

Lending and Portfolio Management income was up 14 per cent, or 8 per cent excluding the impact of a $55 million IFRS9 income adjustment, with double-digit increase in balances on a constant currency basis and improved margins in Corporate Lending.

Wealth Management income grew 12 per cent to a record $2.2 billion reflecting sustained growth in client numbers and double-digit growth in assets under management. There was a particularly strong sales performance in Funds, Structured Notes and Wealth Lending. Bancassurance income was up 9 per cent.

Retail Products income declined 6 per cent or 7 per cent on a constant currency basis. Deposits income declined 41 per cent as margin compression from the low interest rate environment more than offset increased volumes and improved balance sheet mix. Strong volume growth and improved margins led to Mortgages & Auto income increasing 38 per cent and Other Retail Products income growing 28 per cent. Credit Cards & Personal Loans income was up 5 per cent as balances grew on the back of a recovery in transaction volumes.

Treasury income increased 10 per cent with higher interest income partly offset by a $224 million reduction in realisation gains given movements in yield curves.

Profit before tax by client segment and geographic region

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Not meaningful

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Following an organisational restructure that came into effect on 1 January 2021, the new structure results in the creation of two new client segments: Corporate, Commercial & Institutional Banking, serving larger companies and

Group Chief Financial Officer's review continued

institutions, and Consumer, Private & Business Banking, serving individual and business banking clients. From a regional perspective, Greater China & North Asia and ASEAN & South Asia have been combined to form a single Asia region.

Corporate, Commercial & Institutional Banking (CCIB) profit increased 57 per cent, with a $1.6 billion favourable movement from impairment releases in 2021. Income fell 1 per cent while expenses increased 5 per cent.

Consumer, Private & Business Banking (CPBB) profit increased by half, with income growing 1 per cent and impairments reducing by $456 million. This was partly offset by a 3 per cent increase in expenses.

Central & other items (segment) losses increased by approximately half to $299 million with a 21 per cent reduction in expenses more than offset by the $300 million impairment of the Group's investment in Bohai.

Asia profits increased 11 per cent with a $1.1 billion reduction in impairment partly offset by a $410 million negative movement in other impairment including the impairment of the Group's investment in Bohai.

Africa & Middle East profits increased from $13 million to $856 million primarily due to a $688 million reduction in impairment. Income was up 3 per cent and 5 per cent on a constant currency basis while expenses decreased 4 per cent.

Europe & Americas profit was up 67 per cent, benefiting from impairment releases and 4 per cent income growth partly offset by increased expenses.

Central & other items (region) recorded a loss of $720 million, with income down $281 million due to lower returns paid to Treasury on the equity provided to the regions in a lower interest rate environment broadly offset by a $231 million reduction in the UK bank levy and lower other impairment.

Adjusted net interest income and margin

1 Variance is better/(worse) other than assets and liabilities which is increase/(decrease)

2 Adjusted net interest income is statutory net interest income less funding costs for the trading book and financial guarantee fees on interest-earning assets

3 Change is the basis points (bps) difference between the two periods rather than the percentage change

4 Adjusted net interest income divided by average interest-earning assets, annualised

Adjusted net interest income was down 2 per cent driven by an 8 per cent decline in net interest margin which fell 10 basis points year-on-year, reflecting the continued low interest rate environment following the cut in policy rates which occurred in early 2020. Excluding the $171 million benefit from IFRS9 income adjustments booked in the second and third quarter, the net interest margin in 2021 would have averaged 118 basis points. In the fourth quarter, the net interest margin averaged 119 basis points, an increase of 3 basis points in the quarter excluding the impact of the IFRS9 income adjustment booked in the third quarter. This reflects the impact of interest rate rises in certain markets and additional interest income from structural hedging activities within Treasury Markets.

Average interest-earning assets increased 6 per cent driven by an increase in loans and advances to customers and higher investment securities balances. Gross yields declined 51 basis points compared to the average in 2020 predominantly reflecting the impact of continued compression of key interest rates. Excluding the impact of the IFRS9 income adjustment, gross yields declined 54 basis points.

Average interest-bearing liabilities increased 8 per cent driven by growth in customer accounts. The rate paid on liabilities decreased by 45 basis points year-on-year reflecting interest rate movements. This was partly offset by a shift of customer accounts from higher-paying time deposits to lower-rate current and savings accounts.

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Credit risk summary

Income statement

1  Variance is increase/(decrease) comparing current reporting period to prior reporting periods

Balance sheet

1  Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2  Includes reverse repurchase agreements and other similar secured lending held at amortised cost of $7,331 million at 31 December 2021, $8,836 million at 30 September 2021, $4,584 million at 30 June 2021 and $2,919 million at 31 December 2020

3  Change is the percentage points difference between the two points rather than the percentage change

The solid risk-management foundations that the Group has built over time has allowed the Group to focus on emerging strongly from the COVID-19 pandemic, despite the uneven recovery across some markets and industries. In spite of the challenging conditions that remain, the Group has seen improvement in a number of credit metrics with the stock of high-risk assets reducing over 6 consecutive quarters and a $2 billion reduction in credit impairment year-on-year. The Group is well positioned to support our clients as economies recover but continues to remain vigilant to the continued impact of COVID-19 and to sectors such as China commercial real estate that are under particular idiosyncratic pressures.

Credit impairment totalled $263 million, a reduction of $2 billion, representing a loan loss rate of 7 basis points demonstrating the resilience of the overall portfolio.

Stage 1 and 2 impairment charge of $78 million is a decrease of $749 million, reflecting an improvement in the macroeconomic variables incorporated into expected credit loss models, additional collateral and guarantees received on a select number of clients and an improvement in underlying probability of default metrics. The management overlay relating to stage 1 and 2 assets totals $323 million as at 31 December 2021 compared to $353 million as at 31 December 2020. There was a $125 million reduction in the COVID-19 element of the overlay, partly offset by a $95 million overlay booked in the fourth quarter in relation to the China commercial real estate sector.

Stage 3 impairment of $185 million primarily relates to charge-offs within CPBB with net releases within CCIB. There was a $32 million charge relating to the catch-up of interest earned on historically impaired assets and a $15 million increase in the management overlay of stage 3 assets in CPBB, which now totals $21 million.

Gross stage 3 loans and advances to customers of $8.1 billion were 12 per cent lower, primarily due to repayments, client upgrades and write-offs more than offsetting new inflows. Credit-impaired loans represented 2.7 per cent of

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Group Chief Financial Officer's review continued

gross loans and advances, a decrease of 53 basis points.

The stage 3 cover ratio of 58 per cent was stable, and the cover ratio post collateral at 75 per cent decreased by 1 percentage point. This reflects new inflows into stage 3 where the Group is confident that we have a low probability of a significant loss as it benefits from guarantees and insurance which are not included as tangible collateral.

Credit grade 12 balances have decreased by 20 per cent, with client upgrades, downgrades into stage 3 and repayments partly offset by a sovereign ratings downgrade and new inflows.

Early Alert accounts of $5.5 billion have nearly halved, reflecting the net impact of regularisations of accounts back into non-high-risk categories, net impact of downgrades into credit grade 12 and exposure reductions. In the fourth quarter, Early Alert accounts decreased by $1.9 billion reflecting improved operating performance in the Aviation sector. Early Alert accounts are now broadly in line with the level they were at before COVID-19. The Group is continuing to monitor its exposures in the Aviation, Metals & Mining and Oil & Gas sectors particularly carefully, given the unusual stresses caused by the effects of COVID-19, as well as its exposure to Commercial Real Estate, which, with net loans and advances to customers of $19.8 billion is just 7 per cent of the Group's total net loans and advances to customers. The rises in commodity prices have eased credit pressure for certain sectors.

The proportion of investment grade corporate exposures has increased by 7 percentage points to 69 per cent.

Restructuring, goodwill impairment and other items

The Group's statutory performance is adjusted for profits or losses of a capital nature, amounts consequent to investment transactions driven by strategic intent, other infrequent and/or exceptional transactions that are significant or material in the context of the Group's normal business earnings for the period and items which management and investors would ordinarily identify separately when assessing underlying performance period-by period. A reconciliation of restructuring and other items excluded from underlying results is set out on pages 42-47.

Restructuring charges of $507 million for 2021 reflects the impact of actions to transform the organisation to improve productivity, primarily redundancy related charges, the majority of which, including an early retirement programme in Korea, were booked in 4Q'21.

Other items include a $62 million financial penalty paid to the PRA and a $20 million fair-value gain relating to a SC Ventures investment.

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Balance sheet and liquidity

1 Variance is increase/(decrease)comparing current reporting period to prior reporting periods

2 The Group now excludes $15,168 million held with central banks (30.09.21: $16,986 million, 30.06.21: $16,213 million, 31.12.20: $14,296 million) that has been confirmed as repayable at the point of stress

The Group's balance sheet remains strong, liquid and well diversified.

•     Loans and advances to customers increased 6 per cent since 31 December 2020 to $298 billion driven mainly by growth in Financial Markets, Mortgages and Corporate Lending. Volumes declined $4 billion in 4Q'21 with a $9 billion reduction in Treasury Markets balances more than offsetting underlying growth in Corporate Lending and Financial Markets. Excluding the reduction in Treasury Markets, loans and advances to customers grew an underlying 2 per cent in 4Q'21.  

•     Customer accounts of $475 billion increased 8 per cent since 31 December 2020 with an increase in operating account balances within Cash Management and in Retail current and saving accounts partly offset by a reduction in Retail time deposits. Volumes increased $21 billion in 4Q'21 primarily from growth in operating account balances and corporate term deposits

•     Other assets increased 5 per cent since 31 December 2020 while other liabilities were 1 per cent higher. The growth in other assets was driven by increased reverse repurchase agreement volumes and an increase in investment securities held within Treasury Markets. The growth in other liabilities reflects increased repurchase agreements and issued debt securities offset by reduced derivative balances

The advances-to-deposits ratio decreased to 59.1 per cent from 61.1 per cent at 31 December 2020 reflecting the strong growth in customer accounts. The point-in-time liquidity coverage ratio has remained stable at 143 per cent and remains well above the minimum regulatory requirement of 100 per cent.

Risk-weighted assets

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

Total risk-weighted assets (RWA) increased 1 per cent or $2.4 billion since 31 December 2020 to $271.2 billion.

•     Credit risk RWA decreased $0.9 billion to $219.6 billion, with an increase of $10.2 billion from underlying asset growth more than offset by the aggregate of $4.4 billion from favourable FX movements, $3.7 billion impact from model enhancements, $2.2 billion from the partial unwind of negative credit migration and $1.1 billion impact from other RWA efficiency actions

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•     Market risk RWA increased by $2.9 billion to $24.5 billion primarily due to the impact of updated PRA guidance with $3.7 billion Structural FX risk now treated as Pillar 1 market risk RWA, partly offset by the benefit of consolidating market risk RWA following the receipt of a Prudential Regulatory Authority (PRA) permission to consolidate market risk RWA for SCB Malaysia Berhad, SCB Thai PCL and SCB (Vietnam) Ltd

•     Operational risk RWA increased by $0.3 billion mainly due to an increase in average income as measured over a rolling three-year time horizon, with higher 2020 income replacing lower 2017 income

Capital base and ratios

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2 Change is percentage points difference between two points rather than percentage change

The Group's CET1 ratio of 14.1 per cent decreased 28 basis points but remains 4 percentage points above the Group's current regulatory minimum of 10.1 per cent. On a pro forma basis, after the cessation of software relief and other regulatory changes and adjustments detailed below, the CET1 ratio as at 1 January 2022 is 13.5 per cent.

The CET1 ratio of 14.1 per cent declined in the period as approximately 90 basis points of profit accretion was more than offset by distributions, RWA growth, movements in reserves and an increase in regulatory deductions. An increase in underlying RWAs, excluding the impact of FX, reduced the CET1 ratio by approximately 40 basis points. This included a 20 basis points impact from higher market RWA following a clarification of the regulatory treatment of Structural Foreign Exchange risk.

Ordinary shareholder distributions reduced the CET1 ratio by approximately 30 basis points. These distributions included ordinary share buy-backs of $0.5 billion completed in the period which reduced the share count by approximately 2.5 per cent during 2021 and a total 2021 ordinary dividend of 12 cents a share or $370 million. The total 2021 dividend comprised the interim dividend of 3 cents per share and the Board recommended final dividend of 9 cents per share. Payments due to AT1 and preference shareholders reduced the CET1 ratio by approximately 20 basis points. The net effect of other movements in the period reduced the CET1 ratio by approximately 30 basis points as higher regulatory deductions, adverse movements in other comprehensive income and reserves offset the reduction in RWA from currency translation effects.

There are three policy changes expected to impact the calculation of CET1 and or RWAs in 2022. Firstly, the PRA has confirmed that software relief will be excluded from CET1 from 1 January 2022 which will reduce CET1 by 32 basis points. Secondly, recent industry wide regulatory changes to align IRB model performance (the IRB model repair program) will add approximately $4.7 billion of additional RWA from 1 January 2022. Finally, the introduction of standardised rules for counterparty credit risk on derivatives and other instruments (SA-CCR) will add approximately $1.6 billion of additional RWA. The combination of the IRB model repair program and SA-CCR are expected to reduce the CET1 ratio by approximately 31 basis points from 1 January 2022.

The Board has authorised a share buy-back with a maximum consideration of $750 million to start imminently to further reduce the number of ordinary shares in issue by cancelling the repurchased shares. The share buy-back is expected to reduce the CET1 ratio by approximately 30 basis points.

The Group's UK leverage ratio of 4.9 per cent, reduced by approximately 30 basis points due to an increase in on-balance sheet exposures but remains significantly above its minimum requirement of 3.7 per cent.

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Outlook

We have had a solid start to 2022 and we expect income to grow in the 5-7 per cent range with mid-single digit asset growth and an increasing likelihood of some support from interest rates, which should help support margins particularly in the later part of the year.

Expenses are expected to grow $0.4 billion, including the impact of inflation, to $10.7 billion, excluding the impact of currency movements.

Whilst we remain vigilant to the continued uncertainty in the external environment, our loan portfolios are in good shape and, barring major negative events, we would expect impairments to slowly increase from the exceptionally low levels in 2021. Our medium-term cost of risk is now expected to normalise between 30-35 basis points, slightly lower than our previous medium-term guidance of 35-40 basis points.

Although regulatory changes will lead to an increase in RWAs at the start of the year we fully intend to operate dynamically within the 13-14 per cent CET1 range.

Looking beyond 2022, the actions we are undertaking and likely trajectory of interest rates puts us on the path to deliver a 10 per cent return on tangible equity by 2024. With the tailwind of a rising interest rate outlook, we believe we can deliver 8 to 10 per cent income growth per annum between 2022 and 2024, with 5-7 per cent from underlying business growth and a further 3 per cent from rising interest rates.

We are embarking on a $1.3 billion gross structural expense reduction programme, funded by $0.5 billion of restructuring charges, which will free up investment capacity and allow us to deliver 2 per cent positive income-to-cost jaws on average per annum before the benefit of rising interest rates.

The actions we are taking on RWA optimisation means we expect RWAs to grow at a low single-digit percentage. We have reiterated our intent to operate within our 13-14% CET1 target range and aim to deliver in excess of $5 billion of shareholder returns over the next three years.

Andy Halford

Group Chief Financial Officer

17 February 2022

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